Parker-Hannifin Corporation

Q4 2023 Earnings Conference Call

8/3/2023

spk01: Hello and welcome to the Parker Hannafin Corporation's fiscal 2023 fourth quarter and full year earnings conference call and webcast. At this time, all participants are on a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Todd Liam Bruno, Chief Financial Officer. Thank you. Please go ahead.
spk06: Thank you so much, Donna. And good morning, everyone, and thank you for joining Parker Hannafin's Fiscal Year 23 Fourth Quarter and Full Year Earnings Release Webcast. As Donna said, this is Todd Liam Bruno, Chief Financial Officer, speaking. And with me today for the webcast is Jenny Barmentier, our Chief Executive Officer, and Lee Banks, our Vice Chairman and President. I think everyone knows we released our results and all of these slide materials this morning. Our comments today will address forward projections and non-GAAP financial measures. On slide two of this presentation, you will find specific details to the disclosures that we are making in respect to both non-GAAP financial measures and the forward projections. Just as a reminder, actual results could vary from what we speak about today in this presentation. based on all of the items listed here in these disclosures. Our press release, this presentation, and all reconciliations are available under the investor sections at Parker.com and those will remain available for one year. Today we're going to start with Jenny addressing some of the highlights of our strong fourth quarter and really what was a transformational fiscal year for Parker. She is also going to reiterate some reasons that show why Parker is so well positioned for the I'm going to follow up with just some color on how the quarter wrapped up and provide some details around our initial FY24 guidance that we released this morning. Jenny will wrap up the call with some key messages, and then we're going to open up the lines for Q&A for Jenny, Lee, or myself. So now I'll ask you all to move to slide three, and Jenny, I'll hand it over to you.
spk09: Thank you, Todd. Good morning to everyone, and thank you for joining our call today. Q4 was a quarter of outstanding performance across all of Parker, starting with safety. We remain in the top quartile with a 20% reduction in recordable incidents. Safety has been and will remain our top priority. We had record sales of $5.1 billion in the quarter, a 22% increase over a prior year with organic growth of 6%. This is our second quarter above $5 billion in sales. We achieved record adjusted segment operating margin of 24%, a 110 basis point increase over prior year. And as we discussed last quarter, our backlog coverage remains resilient at 55% and has increased 1% sequentially. The wind strategy and portfolio changes have delivered a strong finish to a great year. Next slide, please. A great and transformational year. On the right side of the page, you can see highlights from fiscal year 23. Again, it all starts with our team. Top quartile safety and engagement delivers these results. We now have approximately 30% of the portfolio in aerospace and defense, and we couldn't be happier with the progress of the MEGA integration. The team is exceeding our expectations. And a record $3 billion operating cash flow, 22% higher than prior year. allowing us to make great progress in paying down debt. Todd will give you a few more details on this in his upcoming slides. Next slide, please. Many of you have seen this slide before. As you know, over the past eight years, we have strategically reshaped the portfolio to double the size of aerospace, filtration, and engineered materials. I'd like to draw your attention to the middle of the page for the FY23 updates. The dotted line represents where we originally forecasted our longer cycle and secular trends revenue to be at the end of the year. The arrow and new solid line represent that we have realized a bigger shift to longer cycle revenue. The combination of the portfolio changes and secular trends is all ready and will continue to create a profound shift in our revenue mix. We have high confidence that by FY27 we will have approximately 85% of the company in long cycle end markets and industrial aftermarket. This mix shift is further reason why we will grow differently in the future. Next slide, please. Diving a little deeper into our future sales growth drivers, the five buckets on this slide will allow us to achieve our FY27 target of 4% to 6% organic growth over the cycle. The wind strategy is our business system. It delivers growth and financial performances. Every tool in this system expands margins. CapEx reinvestment is addressing the last decade of underinvestment as well as investments to strengthen and develop the supply chain. This will result in increased equipment spend and higher levels of automation. And under innovation, our new product blueprinting tools and simple by design principles have increased our product vitality index, that is the percent of sales from new products. This enables faster growth and support of the secular trend. The acquisitions we have made are great companies with higher growth rates, aftermarket, and accretive margins. We continue to benefit from the growth related to secular trends. We expect multiple years of solid growth in aerospace, driven by both commercials and defense. And we are enjoying an increased bill of material on all electric passenger vehicles and continue to partner with our mobile customers on electrifying their equipment and helping them to achieve their carbon neutral goals. And today, two-thirds of our portfolio enables these clean technologies. Again, all of this giving us high confidence to grow differently than we have in the past and achieve our four to six percent organic growth over the cycle. Next slide, please. As a reminder, living up to our purpose Top quartile performance and being great generators and deployers of cash is what drives Parker. This slide provides an update on living up to our purpose, enabling engineering breakthroughs that lead to a better tomorrow. We are committed and on track to be carbon neutral by 2040 and achieved a 20% carbon reduction in fiscal year 23. And we are proud to be in the first quartile of the carbon disclosure project on climate change. Post-pandemic, Our teams were anxious to get back into the communities where we work and volunteered over 10,000 hours in fiscal year 23 to help serve others. And again, our clean technologies are critical in helping our customers achieve their carbon neutral goals. Next slide, please. The combination of our growth drivers and living up to our purpose points to a very promising future for Parker. We are committed to our FY27 targets of growing EPS from $21.55 to $30 and achieving 25% adjusted segment operating margin. Growth from secular trends, continued transformation of the portfolio with MEGIT, and continuing to accelerate our performance with Wind Strategy 3.0 will drive top quartile performance and organic growth of 4% to 6% over the cycle. We have entered fiscal year 2024 on a solid foundation. The guidance that we are sharing with you today reflects continued progress to these FY27 goals. Todd will go through the quarter and the guide, and then I will be back with more comments on our guide assumptions and why we are still very bullish about the future and the 4% to 6% organic growth over the cycle. Over to you, Todd.
spk06: Well, thank you, Jenny. If everyone's following, I'm going to start on slide 10. And I'm really proud to say, once again, every Q4 number highlighted in this gold box is a record for the company. It was really just an unbelievably strong finish to the fiscal year. I'm going to try to move quickly because Jenny already spoke to the 22% sales growth and the 24% segment operating margin. But in respect to sales, organic growth was 6%. When you take a look at the MEGIT acquisitions and the divestitures that we did in FY23, the net addition for the quarter was 16%. And the good news here is on currency, the headwinds have moderated. It now was just a slight headwind of 0.4% in the quarter. One thing I do want to note is adjusted EBITDA margins, 24.4%. That's an increase of 130 basis points versus prior year. And if you continue down the page, both net income and adjusted earnings per share did increase by 18% versus the prior year. Our adjusted net income was $791 million, or a 15.5% return on sales. And adjusted EPS was $6.08 in the quarter. That is an increase of $0.92, or 18% versus prior year. Internally, we always stress how important it is to finish strong. And really, these results are just really a testament to the resilience of our global team. So thank you to everyone for a great Q4 and a great fiscal year 23. If you move to slide 11, this is just a bridge on how we generated that $6.08. This is a $0.92 walk. And I'm proud to say, again, you can see the biggest bar on this page is increased segment operating income. If you look at that, we increased segment operating dollars by $264 million. That's nearly 28% increase year over year. That added $1.63 of EPS to our total for the quarter. There were a few headwinds below the segment that are really no surprise. Obviously, that interest is 100% related to MEGIT. That's consistent with what we've seen in past quarters. And income tax was favorable this year in the quarter. Even though we did finish favorable, it was a headwind of 19 cents compared to what we did last quarter. And if you think about that, last quarter we did have a few one-time items that were related with the acquisition that were favorable, and some higher discreets last year. Those were obviously non-repeating issues this year. So the story on the walk is just really strong operating execution, and it's really across the board. If you move to slide 12, just some details on the segment performance. Every segment delivered positive organic growth this quarter, but they also delivered positive margin expansion. You can see across the board here. Incrementals were very strong, and all of these margins are records. And I'm also proud to say, even with the challenging comparisons, orders did increase from last quarter to a plus three versus prior year, and our backlog did increase 1% sequentially and did reach a record $11 billion. So this is really the result of robust aerospace activity, but also the changes to the portfolio that we spoke to throughout the year. Just jumping into the North American businesses, sales were very strong, $2.3 billion, and That was 5% organic. That's really right in line with our guide. Adjusted operating margins did increase 60 basis points to 23.5%, really just driven by excellent execution across those North American businesses. Incrementals also did improve sequentially, and that helped drive our margin expansion. One thing to note, orders did turn negative to 8%, but that really still is against tough comps. We still have strong backlog coverage that we believe will continue to support growth. And customer sentiment overall remains positive in North America. So all in all, a great quarter and a great finish by our North American team members. If you look at the international businesses, sales were $1.5 billion, organic growth nearly 4%. Organic growth did remain positive in all of our international regions, really led by Asia Pacific, 8.5%, almost 8.6%. Latin America was 2.5% positive, and even EMEA, which we've seen some soffits in, did post a 1% positive organic growth. Even with all that said, margins did increase 90 basis points, finished at 23.3% versus prior year, and really still continue to reflect consistent performance, productivity improvement, good cost controls, and that increase in distribution mix that we've talked about periodically. Quarters in the international business did improve from last quarter. They are still negative one, but it is a nice improvement from last quarter. And again, from our international team members, great consistent performance and glad to see these results. If you move to aerospace, this is really the story of the quarter, really a standout, just fantastic results all around. Sales are $1.3 billion, 16% organic. Total sales are a 90% increase versus prior year. That's really obviously benefiting from the MEGIT acquisition. But if you look at the business, commercial OEM and MRO continue to be very strong. Both of those businesses are growing at plus 20% versus prior in the quarter. The military OEM business did return to growth this quarter with high single digits organic performance. That was really nice to see. And operating margins, a new record high. really increasing on an impressive 160 basis points to 25.8%. Those strong margins reflect that growth in the commercial aftermarket businesses and really notably a nice favorable mix of spares versus repairs. So you can also see the addition of MEGIT has also increased our aftermarket exposure. That was one of the compelling aspects of that acquisition. We're glad to see that materialize in the results. The aerospace team is really doing a phenomenal job, obviously dealing with growth. The integration is ahead of schedule and on track, and these results are really fantastic to see. It's really truth that Parker and Megat are really better together. If you look at aerospace order rates, plus 28 continues to be robust, and that obviously is helping our backlog. Great performance across the segments. If I jump to slide 13, I just want to highlight our cash flow performance. We finished the year with extremely strong cash flow. It was a record in FY23. We increased cash flow from operations 22%. We reached a record $3 billion of cash flow from operations. That's 15.6% of sales. Pre-cash flow also very strong, 2.6 billion or 13.6% of sales. Our CapEx came in right where we were forecasting, 2%. And just as a note, because this was the closing of MEGIT, we did have some transaction-related expenses that were a drag to cash flow. That was about 1% of sales, so those obviously aren't going to repeat next year. And we have set ourselves up extremely well to be great generators of cash. If you look at conversion, free cash flow conversion for the year, 125%. And I just really want to thank our teams for the great work on working capital. We strive to be great generators, great deployers of cash at reaching this $3 billion milestone. It's really the result of significant effort from our team across the globe. If you go to slide 14, you can see what we did with all that cash. We reduced debt by $850 million in the quarter. Since we closed MEGIT just this fiscal year in September, we have reduced our debt by $1.4 billion. Since announcing MEGIT way back in August of 2021, we have already paid down approximately 35% of the total consideration of nearly $10 billion. So very impressive work across the board by our team. If you look at leverage, gross debt to adjusted EBITDA finished the year at 2.8%, and net debt to adjusted EBITDA finished the year at 2.7%. excuse me, 2.7 times. We've spoken about our great track record of how we are so dedicated to quickly deleveraging after the deals, and since closing the transaction in September, we have already reduced leverage by one full term, so we're proud of that. Looking forward to next year, we expect to generate significant cash flow. We think we can reduce debt by an additional $2 billion in FY24, and we are targeting leverage of two times in early FY25. Okay, so moving to guidance and putting FY23 to bed, you can see what we are looking at here is slide 15. And I'll start with the top line. Reported sales growth for the year is forecasted to be in the range of 3% to 6% or 4.5% at the midpoint. That equates to approximately $19.9 billion in total sales. If you look at the split, the first half is 49%, and the second half is 51%. Speaking specifically to organic growth for the full year, we expect it to be 1.5% at the midpoint. In respect to aerospace, we're expecting high single-digit growth in aerospace, a little over 8%. North America organic, we expect that to still be positive at plus 1%. And international, we are forecasting slightly negative at 2.5%. Those are all full-year numbers. The backlog that I just spoke of earlier does support our growth, so we feel confident in these numbers. And if you look at the breakdown, the guidance does assume acquisition sales, roughly $500 million from MEGIT, offset by $400 million of the divestitures that we did complete in FY23. So the net impact is $460 million, or about 2.5%. of our total sales. I mentioned currency earlier. Based on spot rates as of June 30th, we do expect currency to be a slight tail end of 0.5% or roughly $100 million. So that is based on currency rates as of June 30th. We still see margin expansion this year. 30 basis points is what we're forecasting for FY24. That is all based on continuing to accelerate our performance across all of our businesses using the wind strategy. and, of course, delivering on mega synergies that we have communicated. If you look at adjusted segment operating margin, our guidance is 23.2% at the midpoint, and there is a range of 20 basis points on either side of that midpoint. If you look at operating income dollars, segment operating income dollars, the split is 47% first half, 53% second half. And for the full year, we are forecasting incremental margins of 30%. A few other items in respect to guidance. Corporate G&A is $240 million. That's a full year number. Interest expense is $525. That is a $40 million reduction from where we finished in FY23, really just based on our strong debt pay down. And other expense is $25 million. Full tax rate, we're guiding at 23.5%. That is without any discrete items. That is really our continuing rate from operations, 23.5%. And finally, we expect full year, as reported, EPS of $18.55, or on an adjusted basis, $22.40. The range, those are both midpoint numbers. The range on either side of those is $0.50, plus or minus. And the splits, 46% first half, 54% second half. And just specifically for Q1 of FY24, we are forecasting adjusted EPS to be $5.10 at the midpoint. Looking at cash flow, full year free cash flow is expected to be between $2.6 billion and $3 billion, so we'll be mid-teens free cash flow and our conversion will be over 100%. Also included in the appendix is some segment guidance details and some other specifics that you might find helpful. If I move to slide 16, this is just the bridge. and really highlights as follows, again, very similar to what's happened throughout this fiscal year, that organic growth, the acquisition sales, margin expansion, and the $75 million of incremental MIGIT synergies for the year translate to an increase in segment operating income of $1.47. We will have less interest expense next year based on that debt reduction that we've done, and that will add 23 cents to EPS. Our forecasted tax rate of 23.5% is a headwind of 26 cents, but you remember we had a lot of favorable items in FY23. We're not forecasting those to continue. We also had lower interest income. If you remember, we pre-funded the mega-transaction in June of last year, so we had interest income in the first quarter of last year. That was about $35 million. Just to note, that is reported in the other expense-slash-income line On the business segment statement, that was a one-off benefit that obviously will not repeat in FY23. That's a 21-cent headwind. The rest is just a forecasted 20-cent unfavorable to EPS, and there's just really some non-repeating items in there. And obviously share count is also a 10-cent headwind that we hope to make up. So that's the walk from FY23 to FY24. EPS at the midpoint is forecasted to be $22.40. Okay. So with that, Jenny, I'll hand it back to you and ask everyone to move to slide 17.
spk09: Thank you, Todd. Just a few key messages to close us out. So FY23 was a tremendous year with record performance. We have top quartile safety and engagement, and that continues to drive results in our business. We truly have a great team. We have a proven track record, and we're going to continue to accelerate our performance with the wind strategy 3.0. The transformation of the portfolio is clearly delivering a longer cycle and more resilient portfolio, and this will allow us to achieve our FY27 targets and continue to be great generators and deployers of cash. So before we go into Q&A, I'd like to give you a few of our assumptions and comments on the guide. So obviously aerospace is a real growth differentiator for Parker in fiscal year 24. We are projecting total aerospace growth at 17% with the acquisition sales from MEGIT and organic growth of 8%. We see strong mid-teens growth in commercial and mid-single-digit in military. Good story all the way around. We have now had two years in a row of double-digit growth for industrial, but having said that, as Todd mentioned, industrial orders have been negative for the past two quarters. However, in North America, backlog coverage is still above 30%, which is roughly double what it has been in the past, and it will support the growth we have in the first half. We do expect some destocking to continue, but overall sentiment from our customers is positive about steady demand and future growth. Obviously, there's more macroeconomic uncertainty for the second half, and we'll update you on that in future calls. While we did see an improvement in international orders from Q3 to Q4, this does include a benefit coming from some of those multi-period longer cycle orders and an easier comp from last year's China COVID shutdown. Again, the backlog coverage remains above 30%, but as Todd said, we are forecasting negative growth for the first half and full year. Since the last time we talked, we've seen some signs of Europe slowing. Customers are returning to those seasonal shutdowns where they do maintenance in their facilities, and we're starting to see some softness in some of the end and geographic markets, as well as some weakening macroeconomic indicators. And although China had stronger growth in Q4 than Q3, recovery is slower than anticipated, and then we will face a tough comp in Q1 against prior year China COVID rebound. So in summary, this is our thinking right now. Strong aerospace growth. strong backlog on the industrial side, some near-term uncertainties and tough comps, but the future growth drivers that I went through on the earlier slide remain intact and activity is at a high level. We are still very bullish about the future and our 4% to 6% organic growth target over the cycle. So now I'll hand it back to Donna for Q&A.
spk01: Thank you. The floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. In order to allow as many individuals as possible the opportunity to ask a question, we do ask you to please limit yourself to one question and one follow-up. Again, that is star one to register a question at this time. Today's first question is coming from Julian Mitchell of Barclays. Please go ahead.
spk11: Thanks and good morning. Maybe just wanted to start off with the industrial businesses. Maybe give us a bit more color on the assumptions for international. It sounds like you've got a down first half organic sales and also down second half organic sales in the guide. So are you sort of assuming heavy negative orders pressure there for the coming six months or so? Just wanted to check that. and broadly on destocking any regions or markets to call out in particular where that's most severe.
spk09: Good morning, Julian. So first of all, to your question on international, like I was talking about earlier, obviously the backlog is still strong. It's above 30%. But those customer shutdowns that I mentioned, that takes weeks out of the schedule that we hadn't seen previously. So a return to that is one of the reasons. And then, obviously, since the last time we talked, we've seen a slowing in Europe. We've seen the demand not be as strong in certain regions. And then the China recovery is, you know, we haven't seen the rebound from the stimulus that had been previously anticipated, so that is all weighing in there as well.
spk11: I see. And maybe just following up on the sort of the destocking comments you'd made, any more color on, you know, markets or geographies most affected?
spk09: Well, we did see destocking happen in Q4, and we just expect that to continue through the first half. I'll let Lee comment a little bit on the specifics of some regions and markets.
spk05: Yeah, Colleen, that's Lee. Good morning. I think destocking is mostly at the distribution level. It's been going on for a couple quarters. They were holding more inventory than usual. But I would tell you the sentiment is still strong. So we've seen destocking across our European distributors and in North America. Maybe, too, just a little more color on Europe, as Jenny was talking about. The biggest softness really is around the dock region. So that would be Germany, Austria, Switzerland. I think it's a couple things. It's the China export market's a big deal for them. China has not rebounded like we all expected it would. And then I think when you pivot to Asia, with China, the property woes continue to weigh heavily on the business community there. So all the stimulus we read about really hasn't trickled down to any significant economic activity. I'm still expecting that to change going forward, but Those are the plus sides as we move forward.
spk07: Hey, Julian, this is Todd.
spk06: I would just add we don't have this really first half, second half weighted. We are forecasting international in total to be about 2.5% for the full year, and if I look across the year, there's no real weighting there. It's about an even split.
spk11: That's great. Thank you.
spk01: Thank you. The next question is coming from Joe Ritchie of Goldman Sachs. Please go ahead.
spk15: Thanks. Good morning, guys, and nice end to your year. Thanks. Good morning. Hey, just wanted to maybe talk a little bit more about North America. Obviously, you've got this little order deceleration, the destocking commentary. Just maybe talk a little bit more about what your expectations are is for orders going forward or any comments you can make about how this fiscal first quarter is trending, that would be helpful.
spk09: Yeah, thank you, Joe. Obviously, we've already talked a bit about what we expect to see, a continuing destocking and just kind of a softening in orders despite a very positive sentiment from the customer. In the first half in North America, we're projecting 2% growth, and overall for the year, 1%. So we think that there's some macroeconomic uncertainty in the second half, but in the first half, we fully believe that this strong backlog is going to support what we have in the guide. So the backlog, again, above 30%. A little bit down, about 2% down from last quarter, but very strong. And, you know, in talking with our customers, you know, we continue to constantly pressure test this and analyze it, and we're not really seeing any major push-outs or cancellations. So we feel good about the guide we have out there.
spk15: Okay, great. And then maybe just focusing to Arrow, I guess it's funny, like you're expecting 8% growth, good growth, but, you know, why is 8% the right number? It feels like it could be better than that. And then particularly with military inflecting. And then also we'd love to get any color around where the integration is going better than expected with MEGIT.
spk09: Sure, sure. So the first half for Arrow is 12%. So obviously we're going to see some nice growth here in the first half and In the second half, we have 5%. And the comps get pretty tough in the second half. So we feel good about that 8% organic number right now. So obviously, we're seeing really nice growth in commercial OEM. We see those narrow body rates increasing. Wide bodies are starting to recover. But really, it's a story about narrow body rate increases. And then MRO. As Todd mentioned earlier, the MEGAD acquisition has really increased our aftermarket exposure, and it's been really strong with the air traffic recovery, especially with those narrow bodies. And we're pleased to see military OEM return. Obviously, the military budget increase is going to drive mid- and long-term growth. F-35 is nearing peak delivery, so all good news there. And then, you know, same thing with military MRO. I mean, there's a There's a focus on retrofits and upgrades as the fleet ages. So really, really good outlook for all of aerospace going forward. So you questioned about MEGIT integration. I mentioned in the slides we couldn't be happier with the progress of that integration. We're forecasting another $75 million in synergies in FY24. The team did a great job in FY23 of pulling some actions ahead and allowing us to increase those synergies by $15 million. So really just a positive outlook for aerospace.
spk15: Sounds good. Thank you.
spk06: Hey, Joe, this is Todd. Just one thing I would add. If you remember a year ago when we did the MEGIT post-close call, we said that we felt MEGIT could add 80 cents of EPS on a full-year basis. We are ahead of that schedule. So that should give you some comfort, too, that it is adding EPS to the bottom line as well.
spk01: Thank you. The next question is coming from Andrew Obin of Bank of America. Please go ahead.
spk02: Hi, guys. Good morning.
spk09: Good morning, Andrew.
spk02: Good morning, Janet, Todd, Lee. Good to hear from you guys. Yeah, just a question on price and cost. Companies are starting to talk about disinflation, maybe some deflation. What's the view on the company's pricing power into next year? and also ability to actually extract price concessions from supply chain.
spk05: So, you know, Andrew, you've covered us a long time. I mean, the one thing I think we've got a good handle on inside the company is kind of price cost and the ability to push cost in the price. Every one of our facilities is embedded in our wind strategy. We look at cost constantly and we look at price constantly. I would say pricing has become much more normal now. We're not in that rapid inflationary period. But, you know, our goal is always to keep things margin neutral. And we're working that. And we're working the cost side on the supply chain side, too. So I'm comfortable that kind of the price-cost scenario we have is baked into our margin forecast and
spk02: Excellent. And then the other question, you know, you sort of talked about seeing Europe slow down, specifically Germany and the DAC region. You know, if you read the newspapers, Economist, Politico, a lot of articles about sort of structural slowdown in Germany, right, because exports to China, cheap energy from Russia. Could you use this slowdown as an opportunity to sort of reconfigure your manufacturing footprint and supply chains in central Europe? I would call it Central Europe or just Western Europe in general. What are your thoughts and, you know, is it too early to say?
spk05: Well, so first off, we've been reconfiguring our supply chains and our manufacturing footprint in Europe for the last eight or ten years. I mean, you remember when Tom and I took our roles, we had a big initiative.
spk02: I absolutely do.
spk05: Absolutely do. So, you know, and I would just tell you that that is always ongoing. So we never stop with that, and we take every opportunity we can to just continue to be better, and we're doing that today.
spk09: Yeah, we don't wait for an event, Andrew. You know, it's something we're always working on.
spk06: You know, Andrew, I think Lee brings up a good point. We've been working that initiative for a long time, and if you look at the margins that I just ran through for Q4 and really what we're guiding for FY24, you'll see that those international margins are similar to every other piece of our business. So that has been a great success.
spk05: Great European team with great leadership doing great things. They really are.
spk02: No, I appreciate you. You've certainly been doing something right. Thanks a lot. Thank you. Thanks, Andrew.
spk01: Thank you. The next question is coming from Nathan Jones of Stiefel. Please go ahead.
spk14: Good morning, everyone. Good morning. Question on the margin guidance in aerospace. Jenny, you just mentioned $75 million of additional synergies for MEGIT in 2024, which I think is about 150 basis points. And the margin guidance is up about 60 basis points. So maybe just some commentary on the core, I guess, margin decline in 2024. Is that really just a function of increasing commercial OEM as part of the mix or something else in there?
spk09: You just answered the question, right? We expect those narrow body rates to go up, and it's definitely a matter of mix.
spk14: Okay, fair enough. That's helpful. And then I guess just on the M&A outlook now, you guys have obviously done a sensational job paying down debt post-Megat, you know, back towards two by the end of the fiscal year, early in 2025. What are kind of your criteria for getting more materially back into the M&A market and the shape of the pipeline? I know you guys continue to cultivate that even when you're out of the market. Just commentary on plans there.
spk09: Yeah, so we're committed first to pay down our debt. That is our number one priority and our focus. We're always working the pipeline. We have longstanding relationships with people we talk to now as we have in the past, so That's not something that we ever let go stale or dry. It's a continuous pipeline. So for now, we're focused on paying down debt, and we expect to get in the range of about two times by fiscal year 2025, and I'm sure we'll talk about it in the future.
spk14: Fair enough. Thanks for taking my questions. Thank you, Nathan.
spk01: Thank you. The next question is coming from Jeff Sprague of Vertical Research Partners. Please go ahead.
spk03: Hey, thank you. Good morning, everyone. Hey, good morning. Good to touch base with all of you. Just wanted to follow up on, Lee, your comments on price-cost margin neutral. I believe you got yourself the price-cost margin accretive through this period. You know, kind of correct me if I'm wrong on that, but should we kind of expect that trend back to neutral, you know, to occur here in 2024? or can you actually maintain some kind of positive spread?
spk05: Well, I think, you know, Jeff, again, you followed us. We've always maintained some kind of positive spread. We're always looking at the portfolio. We're sunsetting products. We've got, you know, different strategic pricing initiatives. But I would tell you, you know, we deal with a lot of core, tough customers, and pricing is very competitive. It's really what we do with the balance of the portfolio that helps us out. And as we've talked about in the past, one of the great strengths of this company is the distribution base we have, which gives us a great opportunity to kind of price into that market.
spk03: Understood. And then, Jenny, just back to Arrow, can you be a little bit more explicit about what your Arrow commercial aftermarket assumption is inside the guide and you know, is the growth similar at Legacy, Parker, Arrow, and Meggitt, you know, on those metrics?
spk09: Yes, I would say, first of all, that it is very similar, but obviously the Meggitt acquisition, as we've mentioned, has meaningfully increased our aftermarket exposure. So it's mid-teens is what we're projecting right now. And, again, that air traffic recovery, especially with the narrowbodies, with this high domestic traffic, Is that really what's going to help that into the fiscal year?
spk03: Great. Thank you very much.
spk09: You're welcome.
spk01: Thank you. The next question is coming from David Rasso of Evercore ISI. Please go ahead.
spk10: Hi. Thank you for the time. On the margins industrially, that you have them up despite an aggregate, your industrial organic sales are down. I just want to make sure I understand the destocking that you're referring to, I think about probably distribution, which would be a challenging mix if that's your D stock. Are you also referencing, though, maybe a more balanced D stock? It's at OEs as well. I'm just trying to get a sense of the ability to have margins up when you're D stocking distributions, a heavy lift. So I'm just curious to get your color on that. And maybe what's in the backlog? It sounds like the backlog will help carry the first part of the fiscal year. Are the margins particularly positive? What will be coming out of the backlog? Just trying to get a sense of the margin progression and how to have margins up if organic's down industrially for top line.
spk09: Yeah. So, you know, David, primarily when we talk about destacking, we are talking about distribution. But, you know, we're just seeing kind of a moderation of growth across all of our customers. Don't worry about margin degradation. We're not going to allow that. We have all the right things in place to make sure that we hit our margin targets. So really, it's about we're just continuing to see the benefit of this transformed portfolio. We're continuing to see the power of the acquisitions that we've done over the last several years.
spk07: Hey, David, this is Todd. I would just add to that. Jenny is absolutely right.
spk06: We do believe that we can expand margins both in the North American businesses and the international businesses. It really is a testament to the power of the wind strategy. But if I'm looking at the numbers here, it really is a smooth glide path, very similar to what we've done historically with our normal seasonality. So it's not weighted in any one way or the other. I gave a little color on the splits of seven operating income, but the margin expansion is a nice glide throughout the year.
spk10: And maybe I missed it, just clarification. The first quarter in North America particularly has a hard comp. Are we saying margins could be up every quarter in North America, or is it just for the full year and the first quarter is down and then it's up from there?
spk06: No, we see margin expansion in every quarter this fiscal year.
spk10: All right. Thank you so much.
spk06: Thanks, David. Thanks, David.
spk01: Thank you. The next question is coming from Josh Pokowinski of Morgan Stanley. Please go ahead.
spk04: Hi, good morning, y'all. Good morning. Jenny, you've referenced the backlog here a few times. I think for most folks, they don't really think about backlog when they think about the industrial pieces of Parker. Clearly, that's changing, but maybe some more kind of breakdown of how long does that backlog extend out? Is there a particular set of end markets or, you know, channel mix, like I would assume more OEM, maybe more project activity, just any kind of color you can give us on the nature of that backlog and really the duration over which it ships. Is it, you know, kind of one to two quarters, three, four, or something like that?
spk09: So, you know, the backlog, as I've said, is, you know, at 55% right now and it went up 1% sequentially. So, We talk about that backlog being so strong, and especially, obviously, aerospace is in there, but industrials being above 30% is roughly double what it was in the past. So we were sitting around 15% to 17% coverage in the past, and now we have 30%. So that's really coming from the acquisitions we've done, the higher aftermarket, the longer cycle. So we're seeing a more resilient and longer cycle I call it the demand horizon, a longer horizon on that backlog. So we feel very strongly about it. Now, we know from the past that backlog isn't bulletproof, but we are constantly pressure testing it, analyzing it, talking to our customers, which is really a great benefit of us being so decentralized because our divisions can have real-time conversations to make sure that that backlog is strong. So I wouldn't... be able to break out all the detail that you were just asking about between the channel and the OEM, but I would tell you that over 30% coverage in industrial is a good place to be right now. And that's why we feel good about it covering the growth we have in the first half.
spk04: Got it. That's helpful. And then, oh, yeah, please, go ahead.
spk06: This is Todd. I was just going to add to that. You know, the other thing to keep in mind is when we talk about the company having 30% aerospace exposure, 5% of that exposure, that does come from our industrial businesses. So that is also a plus there as well.
spk04: Understood. That's helpful. Um, and then just pivoting to something I've heard a lot of your peers talk about, you know, particularly this quarter on us mega projects, or I guess North America, mega projects and near shoring, obviously you folks play in all stages of that, I guess, you know, new products that are being developed here as well as the construction of maybe some of these facilities themselves open-ended question, but it's, it's, That's something that in, you know, Parker's, I guess, more kind of component and subsystem-type business that you're actually seeing yet, or is it just a little too early and maybe we see that more, you know, kind of later in 2024?
spk09: You know, we are seeing some of it, you know, through our customers and our distributor partners, and you're right. There's just been a massive amount of announced CapEx. I mean, some industry sources are citing over $500 billion. Some key examples of that where we will get into the game is the semi-fabs and the electric vehicle battery plants that are now breaking ground. So we win. Parker wins when the job site is prepped, when the factory is built, and when the machines go into the factory. So it's early days, but Parker is winning and will continue to win in the future.
spk04: Great. Appreciate it. Best of luck the rest of the year. Thanks, Josh.
spk01: Thank you. The next question is coming from Joe O'Day of Wells Fargo. Please go ahead.
spk13: Hi. Good morning. Thanks for taking my questions. Good morning, Joe. Good morning. Todd, I wanted to circle back. You talked about MEGIT trending ahead of that $0.80 that you had given about a year ago. Just any sort of color on what you think the all-in MEGIT contribution is this year?
spk06: Yeah, I would say it's slightly above that 80 cents that we really forecasted for the first full 12 months. So, you know, we've only owned them nine and a half months, but it has been a fantastic nine and a half months. You know, we've talked about the synergies being ahead of schedule, but the other thing is, you know, they are benefiting from this secular trend in aerospace. So their growth has exceeded expectations every quarter since the close. So, yeah, You know, we feel really good about that. I'm really happy we got the deal done.
spk13: I got it. And then, Jenny, I wanted to circle back the macro CapEx investment sort of drivers that you talked about, kind of the three main buckets with underinvestment, supply chain, megaprojects. Can you just talk about within those buckets, if you can rank order, what you're seeing as the biggest growth drivers for you, but also just what you're seeing in terms of the evolution of them, maybe where things are accelerating, where things have played out a little bit more?
spk09: Well, I don't know that I can rank them right now, but I would tell you that I see activity in obviously all three of them. If you start off just thinking about the CapEx investment because of the reinvestment over the last 10 years, We're seeing just some upgrading of factories, a lot of work being done to really develop the supply chain and increase capacity. That ties into the investment, a lot of machinery and a lot to help really that supply chain development. A lot of folks that got burned during the pandemic are are going to dual sources, so that drives a lot of investment. And as I mentioned just a few minutes ago, the mega projects, we're starting to see some of that. We're hearing about involvement in that from some of our distribution partners. And it's still early days, but there's a lot out there for us to go in.
spk13: Thank you.
spk01: The next question is coming from Jamie Cook of Credit Suisse. Please go ahead.
spk08: Hi, good morning. Congrats on a nice quarter. I guess most of my questions have been asked, but I guess just to, you wouldn't know this from looking at your results, but in 2023 or 2022, is there any way you can handicap the inefficiencies, you know, running through your earnings, whether it's related to, you know, supply chain, you know, employees not being back, et cetera. And I'm just wondering if any of this is an opportunity for 2024 potential tailwind that's not implied in your guides. And then my second question, Lee, I don't think you said this yet. I know you walked through some end market color, but last quarter you told us like the percent of the portfolio that was growing versus not growing. I think last quarter, 90% of the portfolio was still in growth mode. Can you give us an update just on your portfolio percent flat versus growing versus negative? Thank you.
spk05: So, yeah. Jamie, it's Lee. I guess I'll start on a couple things. One, in terms of, you know, we're always striving for productivity and continuous improvement, so certainly things coming out of COVID were chaotic. Some of that chaos is settling down, so those are opportunities for us, but productivity is increasing. You see it in our numbers, and kind of the inefficiencies of work going on are getting better. It's not perfect. There still are supply chain issues out there, but it's a far cry from what it was before. I would say when we look at our markets from the backlog we have, you know, all our markets are still growing at different levels. I mean, it's kind of interesting. Nobody talks about oil and gas anymore, but that's been incredibly strong, land-based oil and gas here and even offshore here and in Europe. Everything in aerospace is great. And forestry and automotive is still great. North America, anything around electric vehicles is doing really well, and we share a lot of content in those areas. And then construction equipment is still steady throughout all that, as is ag. I think some of the areas that have softened, and you've seen it with public announcements, is the whole area of HVAC is down. I think that's short term. That will come back. And semi-con is soft. And life sciences, really, just tough comps coming out of COVID. Things were really going there. The sentiment is it's just tough comps. So it's getting better as we kind of cycle through the comps.
spk06: Hey, Jamie, this is Todd. I would just add to that. On your 90% question, you know, if you look at our total orders, last quarter they were plus 2%. They did move to plus 3%. So there really hasn't been a material change in that percentage of the markets that continue to grow.
spk01: Thank you. Thank you. The next question.
spk06: Hey, Donna. Sorry to interrupt you. This is Todd. I think we have time for one more question. So whoever you have next in the queue, that'll be our last call.
spk01: Okay. The next question is coming from Jeffrey Hammond of KeyBank Capital Markets. Please go ahead.
spk12: Hey, good morning, everyone. Good morning, Jeff. Good morning, Jeff. Just a couple of questions. Supply chain and Aero has kind of been a problem point. Just wondering what you're seeing there and how that kind of informs kind of the growth rate and how much it's maybe holding the growth back.
spk09: Yeah. So, you know, it's interesting. I've been talking to a lot of people about supply chain as always. And, you know, the aerospace supply chain is really experiencing what the industrial side of the business did 18 to 24 months ago. So it's a little bit tough. There's constraints responding to the high rate increases in demand. But I would tell you that outside of chips and electronics, we're starting to see some lead times moderating. But overall, I would say it's still a constraint for aerospace. So again, we work closely with our suppliers. We're investing in developing suppliers, especially in aerospace, because obviously with it being a third of our portfolio, it's very important to us that we can deliver these orders.
spk12: Okay, great. And then I think as was the case with Lord Exotic, the deleveraging process is pretty swift here and seems maybe a little bit ahead. Just level set us on when we start to shift away from debt pay down?
spk07: Hey Jeff, this is Todd.
spk06: Obviously Jenny mentioned it earlier. We are fully committed to debt pay down. So if you look at what I mentioned earlier, we expect to pay down another $2 billion of debt in this fiscal year of FY24. We don't expect to get to 2.0 times till early FY25. So we talked about the portfolio. We never stop looking at it both from an addition and a subtraction standpoint, but our main focus really still for FY23 is to continue that debt pay down trajectory.
spk12: Okay, thanks so much.
spk06: Thank you. Okay, this concludes our FY23 Q4 webcast. As always, we fully appreciate everyone's interest in Parker. Jeff Miller, our VP of Investor Relations, and Yen Hua, our Director of Investor Relations, are available if anyone needs any further clarifications or has any questions on any of the materials we covered this morning. I want to really thank everyone for joining. We appreciate your support. Thanks.
Disclaimer

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Q4PH 2023

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